Forget the Cliff; Beware the Ceiling

For all the worry, the fiscal cliff was just a preview of the
debt-ceiling ruckus ahead. Here's why that could be worse for investors-and how
to get through it, counsels MoneyShow's Jim
Jubak, also of Jubak's Picks.

You ain't seen nothin' yet.

Unfortunately.

The cliffhanger of a fiscal cliff deal was just a dress rehearsal for the
late-January/early-February battle over raising the debt ceiling. This time it's
worse-and more worrisome for investors. This one could really move
global markets-and move them fast and hard, in the not-so-distant
future.Here are three reasons why, plus a strategy for getting past it.

The Crises AheadThis time the damage from missing the
deadline for a deal sets in on Day One. The negative effects of not reaching a
fiscal cliff deal on taxes and spending on Jan. 1 or thereabouts was never going
to be immediate. In the fiscal cliff crisis, tax rates indeed would have gone up
immediately, but tax payments would have increased gradually and spending cuts
would have been phased in over time. The damage to the US economy from a fiscal
cliff failure would have been major-perhaps enough to send the economy
back into recession-but it would have been felt only gradually. That's why
economists, Wall Street pundits, and politicians kept saying that it was
possible to go over the cliff and still fix the problem before the economy
suffered major damage. (This was the so-called bungee-cord strategy.)

That's not true of the debt-ceiling crisis. This time, the damage is likely
to be big and immediate, and some of it won't be easily reversed.

This crisis is really three crises in one:

Crisis No. 1 is the raising of the debt ceiling. If
Congress doesn't raise the current $16.4 trillion debt ceiling, the Treasury
can't increase net borrowing to pay the country's bills. In practice, the
Treasury has ways to manage the country's debt levels so that it can pay US
obligations until, according to estimates from the Congressional Budget
Office, mid-February. After that, the Treasury would have to decide to pay
some bills and not others. You can bet it would continue to pay the interest
on US debt, even if it had to raid other budget lines to do so. Default on US
debt obligations would throw the US and the rest of the world into financial
market chaos.

Crisis No. 2 hits shortly after the Treasury runs out of
room to finagle. The fiscal cliff deal put off $1.2 trillion in automatic
spending cuts divided equally between defense spending and domestic
discretionary spending-this is what's called the
sequester-that were set to gradually take effect after Jan. 1,
according to the terms of the Budget Control Act of 2011, which ended the most
recent battle over the debt ceiling. (About $100 billion in automatic cuts
would go into effect in the 2013 fiscal year that ends on Sept. 30.) The Jan.
1 fiscal cliff deal postponed the cuts until March 1. So, sometime in the next
six to seven weeks, Congress will have to resolve the automatic budget cuts it
has failed to address in a meaningful way in the past 18 months or so.
Otherwise, federal spending gets whacked by $100 billion this
year-with more cuts to come. That's certainly enough to take a bite
out of first-quarter growth in gross domestic product that economists already
fear could dip to a rate of just 1%.

Crisis No. 3 comes close on the heels of Crisis No. 2.
The September 2012 continuing resolution that authorized spending by the
federal government expires March 27. Unable to pass an actual budget or the
appropriation and spending bills that go with it, our government in Washington
has been operating under a continuing resolution that authorized spending for
the first half of fiscal 2013. Unlike a failure to raise the debt
ceiling-which would lead to the government paying some bills and not
others-failure to extend the continuing resolution would mean that
the federal government wouldn't have authority to spend any money. Here, we're
looking at something that would actually shut down the federal government.

The two sides have already begun to double-down on their rhetoric.
Congressional Democrats, afraid that President Barack Obama will negotiate
spending cuts on entitlements including Social Security and Medicare, are urging
the President to get tough. House Minority Leader Nancy Pelosi, D-Calif., has
said the President should invoke the 14th Amendment to raise the debt ceiling by
presidential order. Section 4 of that amendment says, "The validity of the
public debt of the United States, authorized by law, including debts incurred
for payment of pensions and bounties for services in suppressing insurrection or
rebellion, shall not be questioned." Some constitutional lawyers-along with some
Congressional Democrats and some members of the Obama administration including
Treasury Secretary Timothy Geithner-have argued that this language makes the
debt ceiling itself unconstitutional and gives the President the power to simply
raise or ignore the debt ceiling. (So far, the White House, aware that such an
assertion of power would provoke a constitutional crisis, has said it does not
intend to invoke the 14th Amendment.)

On the Republican side, Senate and House leaders facing a revolt by
conservative Republicans have declared any further tax increases off the table.
On Sunday, Republican Senate Minority Leader Mitch McConnell of Kentucky said,
"The tax issue is finished, over, completed." That will come as a surprise to a
White House that is holding to its position that any spending cuts must be
balanced 1-to-1 by tax increases. Such extreme positions seem to mark the
beginning of negotiations in Washington these days. And the distance between
these positions, even if they are rhetorical posturing, is certainly enough to
make reaching any agreement a long and drawn-out affair with big potential to
worry the market.